Elections May Hinder Asian Reforms

The U.S. Federal Reserve’s decision to keep its easy monetary policy in place for now has given Asia time to prepare for the eventual drawback of foreign capital.

But upcoming elections mean policy makers are unlikely to take the hard decisions needed to make their economies more resilient once the Fed does move.

Indonesia and India, the two Asian economies hit hardest this summer when investors pulled out of emerging markets in anticipation of Fed tightening, are both slated to hold national elections next year –in April and July in Indonesia, and by the end of May in India.

“This is the time to say, ‘Here’s the path forward,’” said Randall Kroszner, a former U.S. Federal Reserve governor. “With elections coming up, that will be difficult to do.”

Both countries fared well when global credit was cheap and China’s economy was booming, but now they’re facing scrutiny from investors who want to see the two economies become more productive before committing their money.

Large subsidy programs that keep commodities like fuel and food cheap for consumers mean there’s less public money available for infrastructure and education investments that can increase long-term productivity. And subsidy programs can quickly swell to unsustainable levels, raising investor doubts about a government’s fiscal responsibility.

Subsidies in countries like India and Indonesia are designed to protect the poorest members of society – and win their votes. They’ve been an ever-expanding part of economic policy, and rolling them back will be no easy task.

“Even with fuel and electricity subsidies being provided by the government, I still have to borrow money from my neighbors occasionally,” said Yusuf Setiawan, who makes around $200 a month as a courier with a freight forwarder in Jakarta. Mr. Setiawan says the subsidy payments help him make ends meet for his two young children.

“I will not vote for any party that plans to reduce such subsidies,” he said.

The issue wasn’t so pressing when energy and food prices were low and government debt burdens smaller, but as the subsidy bill has grown the problem has become acute.

In India, the government has budgeted 2.3 trillion rupees ($37.4 billion) for subsidies in the fiscal year ending March 2014 — up from up from 0.7 trillion rupees in fiscal 2008 and 0.4 trillion in 2003. Recent rupee depreciation means the actual bill for 2014 may end up being even higher.

In Indonesia, fuel subsidies are expected to cost 199.9 trillion rupiah ($17.8 billion) this year, some 12% of total government spending.

In both countries, the subsidies take up around 2% of national output.

“The importance of subsidy reform for fiscal sustainability and market sentiment is very well demonstrated by recent events in the region,” said David Coady , a senior official in the International Monetary Fund’s Fiscal Affairs Department, referring to the emerging-market selloff over the summer. “These problems will not go away until governments set out a clear medium-term strategy for comprehensive subsidy reform.”

India has made some progress reducing fuel subsidies in recent years, relinquishing control over gas costs and allowing regular increases in the price of diesel. But subsidies for fertilizer and food help two important pools of voters — farmers and the poor – making them nearly untouchable.

In September the government approved a controversial bill to raise spending on food subsidies by around $4 billion, to roughly $20 billion a year.

“It is not a question of whether we can afford to implement this bill,” Congress Party President Sonia Gandhi said ahead of the law’s passage. “We just have to do this.”

It’s not even clear that subsidies help redress inequality. The IMF says higher-income households gain the most from energy subsidies, exaggerating rather than reducing inequality. An Indonesian government study found that around 80% of its fuel subsidies went to middle-income families with cars. Officials are keen to limit the use of subsidized gasoline by private cars, but admit that implementation would be difficult.

Even when subsidies are cut, countermeasures may be needed to blunt the pain for society’s poorest.

In June, Indonesia took the unpopular decision to raise fuel prices by an average 33%. But cash payments to the poorest citizens to offset the higher fuel prices meant government coffers saw little net benefit.

Other Asian countries also are finding it tough to wean themselves off subsidies.

After coming to power in 2011, Thai Prime Minister Yingluck Shinawatra’s government started buying rice at as much as 50% above the market rate – fulfilling a populist campaign pledge – to boost rural incomes and domestic demand. Rice exports plummeted.

The government this month reduced the rate it pays for some rice and set limits on the amount each household can sell. But the subsidy bill is still expected to reach 270 billion baht ($8.6 billion), or 2.4% of GDP, in the fiscal year starting this month.

The government hopes the move will help save 3.3 billion ringgit a year. Analysts expect further subsidy cuts in Malaysia’s 2014 budget, due later today.

Rachel Calvert, senior consultant for the Asia-Pacific region at IHS Economics & Country Risk, says the Philippines can serve as an example for Asia: The government set up an independent regulatory body that completely removed electricity subsidies by 2006.

“That model has potential for other countries in the region, but it requires a massive release of political control,” Ms. Calvert said. “When there’s a culture of using subsidies to win votes, it’s difficult to do and would require a very bold move by elected officials.”

I-Made Sentana in Jakarta, Anant Kala in New Delhi, Warangkana Chomchuen in Bangkok and Abhrajit Gangopadhyay in Kuala Lumpur contributed to this report